Following a couple of years of apparent progress toward improved investor protection, investor advocates are growing increasingly worried that securities regulators are now drifting away from that objective.

The latest submission by the Ontario Securities Commission’s (OSC) investor advisory panel (IAP) states very bluntly: “This has been a bad year for the retail investor in Ontario. Last year, this panel applauded the OSC’s retail investor agenda. We are unable to do so this year.”

The IAP’s comment on the OSC’s latest statement of priorities, which sets the OSC’s agenda for the year ahead, laments that regulators aren’t making any real progress toward enhanced protection for retail investors.

The IAP comment also calls the client relationship model (CRM) reforms “inadequate” and notes that the CRM still is not in place “after close to 15 years of debate, development and delay.”

Further, the IAP comment says an initiative to provide up-front disclosure to mutual fund buyers “has somehow needlessly dragged on for 13 years” and remains subject to debate. (See sidebar, below).

The IAP comment also notes that in the two years since the Canadian Securities Administrators (CSA) launched consultations into the prospect of introducing a “best interest” duty, nothing has been promised beyond further debate and study.

In fact, the IAP comment says that the OSC is drifting away from seeking more robust retail investor protection and focusing too much on facilitating the raising of capital and curbing the regulatory burden.

Those worries are echoed in the submission from Canadian Foundation for Advancement of Investor Rights (a.k.a. FAIR Canada), which says that investor advocate is “concerned about what we perceive to be a shift in focus from investor protection to other concerns that are not at the core of the OSC’s mandate.”

FAIR Canada’s comment calls the investor protection initiatives set out in the OSC’s plan for the coming year “relatively weak” and adds that these initiatives do not signal an intention to improve outcomes for retail investors. Says the comment paper: “Canadian investors require a real commitment to action, not just further research, consideration or review of these important priorities.”

For both FAIR Canada and the IAP, the OSC’s promises to continue studying the prospect of imposing a best interest duty upon financial advisors and possible reforms to existing mutual fund fee structures rather than pursuing concrete action in either area is a central concern.

This research doesn’t appear to be a top priority. Earlier this year, the OSC publicly tendered a contract commissioning further independent research on mutual fund fee structures, but that contract has not yet been awarded.

More troubling, the OSC has yet to commission similar research on the best interest issue and has failed to carry out a regulatory impact analysis on this topic – analysis that was promised in last year’s statement of priorities.

The IAP’s comment lays much of the blame for the lack of progress at the feet of the CSA, which “has repeatedly demonstrated an inability to reach consensus on a timely basis and to work effectively to create a robust investor protection regime for Canadian investors.”

As a result, the IAP is calling on the OSC to go it alone if it can’t get the rest of the CSA to agree on reforms, arguing that the OSC’s primary job is to protect investors in Ontario: “Investors in Ontario should not pay the price for Canadian regulators’ inability to reach consensus.”

To that end, the IAP supports the immediate introduction of a best interest standard in Ontario, which the comment calls “a basic step in investor protection and long overdue.”

There’s some precedent for securities regulators going it alone on an important policy issue. For example, the current CRM reforms got their start as an OSC-only initiative before morphing into a national effort involving the rest of the CSA and the self-regulatory organizations. Other projects – such as the recently revived reforms to venture issuer disclosure – have had their genesis with other individual regulators that are particularly sensitive to the concerns of junior companies.

Although FAIR Canada isn’t as critical of the CSA in its comment, it also calls on the OSC to forge ahead and propose a framework for introducing a statutory best interest standard in its current fiscal year, which ends March 31, 2015.

FAIR Canada also worries that the OSC is going ahead with new priorities that seem contrary to stronger investor protection, such as introducing a slate of new prospectus exemptions that will enable firms to raise capital more easily and in a variety of new ways but may expose investors to new, untold risks. Indeed, investor advocates worry that the expansion of the exempt market is taking place without adequate research.

The quantity of capital raised in the exempt market already outstrips what’s raised in the regulated market, and FAIR Canada worries that investors will effectively be pushed further in this direction if a wider selection of prospectus exemptions is made available.

This is a concern, FAIR Canada suggests in its comment to the OSC, because past regulatory reviews have shown widespread weaknesses in compliance with the requirements that exist in the exempt market and because this would seem to run counter to the CSA’s core message regarding investor education, which encourages investors to ensure they’re dealing with registered firms and products: “We caution the OSC to be aware of these contradictory messages that are being sent to investors and stress the need for regulators to consider whether these messages can be reconciled.”

The other major area of concern for both FAIR Canada and the IAP is investor restitution. Their comments point out that the main venue for retail investor restitution – the Ombudsman for Banking Services and investments (OBSI) – has been undermined by recent resistance within the industry to OBSI’s recommendations and its inability to impose its decisions on firms.

Moreover, the IAP comment notes, the OSC made a commitment to research options for improving investor access to restitution in 2007 and apparently nothing has been done: “It is long past time for the OSC to put the issue of restitution back on its list of priorities.”

Concerns with point-of-sale disclosure

Investor advocates complain that reforms to point-of-sale disclosure for mutual funds still aren’t final. Yet, some fundamental questions about the regulators’ approach to enhancing upfront disclosure remain, which may spark further resistance within the mutual funds industry.

Earlier this year, the Canadian Securities Administrators (CSA) finally proposed rule changes that would require Fund Facts, the new concise mutual fund disclosure document, to be provided to investors before they decide to buy units in a fund. Fund Facts has been slowly replacing prospectuses as the basic disclosure vehicle for mutual fund investors, but had yet to be required to be provided to clients up front, as originally intended.

As of June 13, investors must receive Fund Facts within two days of buying units in a fund. The CSA suggests that pushing delivery of the document to the point of sale (POS) will represent a relatively minor change for firms – although doing so is expected to empower investors to make more informed investing decisions.

But that’s not the way that some firms see it. The comments submitted on the proposal to require POS delivery reveal persistent concerns with the proposals within the industry. Some comments argue that the two-day shift from post-sale to POS delivery is a bigger deal for firms than the regulators think, and that implementation will require some major changes in back-office processes, staff training and communications. These changes, some comments argue, demand a transition period of up to two years.

A couple of the big banks’ comments also object to the CSA’s decision to require discount brokers to deliver Fund Facts up front. Other comments contend that the regulators should be prepared to accept the “access equals delivery” principle, which would allow firms to satisfy their delivery obligations by providing an online link to the Fund Facts rather than the documents themselves.

Many of these comments amount to haggling over the final details, but there also are suggestions that more fundamental concerns remain. Several comments stress that these same disclosure requirements also should apply to exchange-traded funds (ETFs) and segregated funds.

In fact, the Fund Facts project began as an effort to create simpler, more comparable disclosure for mutual funds and seg funds. Yet, differences remain between the two regimes, which some firms in the mutual fund industry argue puts them at a disadvantage.

The CSA has indicated it intends to propose a rule requiring similar disclosure for ETFs in the autumn – albeit on a post-trade basis.

Meanwhile, the submission from Invesco Canada Ltd. throws some doubt on the underlying objective of the entire project, which ostensibly is to help investors make better informed investment decisions. The Invesco comment notes that a 2009 study shows that “pre-trade delivery of a summary document in lieu of a prospectus merely hastens the speed with which the investment decision is made but has no other impact, including on the quality of the investment decision.”

The comment adds that while the CSA is aware of this study, the regulators have not dealt with the possible implications for the study’s approach to POS disclosure: “Without addressing this issue, we believe the benefits of the proposed amendments may be illusory, but with structural costs that are unacceptable.”

Given the possible implementation costs for dealers, along with other costs, the Invesco comment warns that an insufficient transition period could “invite an additional round of lobbying at the ministerial level” after the regulators finalize their rules.

Although ministerial intervention with a final rule is rare, it does happen. And it’s always possible regulatory policy may yet be killed by political interference.

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